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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____ TO _____.
COMMISSION FILE NUMBER 0-26146
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HNC SOFTWARE INC.
(Exact name of registrant as specified in its charter)
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DELAWARE 33-0248788
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5935 CORNERSTONE COURT WEST
SAN DIEGO, CA 92121
(Address of principal executive offices, including zip code)
(619) 546-8877
(Registrant's telephone number, including area code)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS: YES [X] NO [ ]
AS OF JULY 30, 1999 THERE WERE 24,183,571 SHARES OF REGISTRANT'S COMMON STOCK,
$0.001 PAR VALUE, OUTSTANDING.
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INDEX LISTING
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Page
Number
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PART I FINANCIAL INFORMATION
Item 1: FINANCIAL STATEMENTS
Consolidated Balance Sheet at June 30, 1999 (unaudited)
and December 31, 1998 3
Consolidated Statement of Income (unaudited) for the three
and six months ended June 30, 1999 and 1998 4
Consolidated Statement of Cash Flows (unaudited) for
the six months ended June 30, 1999 and 1998 5
Consolidated Statement of Changes in Stockholders' Equity
and Comprehensive Income (unaudited) for the six
months ended June 30, 1999 6
Notes To Consolidated Financial Statements (unaudited) 7
Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 12
Item 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 27
PART II OTHER INFORMATION
Item 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 28
Item 6: EXHIBITS AND REPORT ON FORM 8-K 30
Signatures 31
Exhibit Index 32
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PART I - FINANCIAL INFORMATION
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Item 1: FINANCIAL STATEMENTS
HNC SOFTWARE INC.
CONSOLIDATED BALANCE SHEET
(in thousands, except per share data)
ASSETS
JUNE 30, DECEMBER 31,
1999 1998
----------- -----------
(unaudited)
Current assets:
Cash and cash equivalents $ 24,406 $ 54,267
Investments available for sale 18,307 41,095
Accounts receivable, net 62,059 58,078
Current portion of deferred
income taxes 10,163 10,163
Other current assets 4,923 5,459
----------- -----------
Total current assets 119,858 169,062
Property and equipment, net 20,769 14,495
Deferred income taxes, less current
portion 10,495 12,829
Long-term investments available for
sale 56,315 57,978
Intangible assets, net 21,555 25,103
Other assets 15,015 4,447
----------- -----------
$ 244,007 $ 283,914
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 7,174 $ 4,226
Accrued liabilities 13,917 16,123
Deferred revenue 9,996 9,427
Other current liabilities 17 78
----------- -----------
Total current liabilities 31,104 29,854
Convertible Subordinated Notes 100,000 100,000
Other non-current liabilities 96 1,039
Stockholders' equity:
Preferred stock, $0.001 par value - 4,000 shares authorized:
no shares issued or outstanding -- --
Common stock, $0.001 par value - 50,000 shares authorized:
24,064 and 25,894 shares issued and outstanding,
respectively 24 26
Paid-in capital 140,023 134,674
Retained earnings 23,950 18,481
Accumulated other comprehensive loss (809) (160)
Common stock in treasury, at cost -
2,266 shares (50,381) --
----------- -----------
Total stockholders' equity 112,807 153,021
----------- -----------
$ 244,007 $ 283,914
=========== ===========
See accompanying notes to consolidated financial statements.
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HNC SOFTWARE INC.
CONSOLIDATED STATEMENT OF INCOME
(in thousands, except per share data)
(unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED ENDED
JUNE 30, JUNE 30,
-------------------------- -------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
Revenues:
License and maintenance $ 41,336 $ 33,796 $ 77,807 $ 60,678
Services and other 14,597 9,345 27,315 17,544
----------- ----------- ----------- -----------
Total revenues 55,933 43,141 105,122 78,222
----------- ----------- ----------- -----------
Operating expenses:
License and maintenance 10,122 8,175 20,839 14,147
Services and other 10,327 6,886 18,984 11,658
Research and development 11,608 7,605 21,128 14,466
Sales and marketing 10,763 8,807 20,541 16,448
General and administrative 5,063 3,674 9,643 7,005
In-process research and development -- 4,340 -- 6,090
Acquisition related amortization 2,056 806 4,308 806
----------- ----------- ----------- -----------
Total operating expenses 49,939 40,293 95,443 70,620
Operating income 5,994 2,848 9,679 7,602
Other (loss) income, net (17) 641 286 1,042
Minority interest in income of consolidated subsidiary -- (38) -- (60)
----------- ----------- ----------- -----------
Income before income tax provision 5,977 3,451 9,965 8,584
Income tax provision 2,632 2,943 4,496 5,689
----------- ----------- ----------- -----------
Netincome $ 3,345 $ 508 $ 5,469 $ 2,895
=========== =========== =========== ===========
Earnings per share:
Basic net income per common share $ 0.14 $ 0.02 $ 0.22 $ 0.12
=========== =========== =========== ===========
Diluted net income per common share $ 0.13 $ 0.02 $ 0.21 $ 0.11
=========== =========== =========== ===========
Shares used in computing basic net income per common
share 24,498 25,290 25,078 24,987
=========== =========== =========== ===========
Shares used in computing diluted net income per common
share 25,000 26,689 25,706 26,436
=========== =========== =========== ===========
See accompanying notes to consolidated financial statements.
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HNC SOFTWARE INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(unaudited)
SIX MONTHS ENDED JUNE 30,
---------------------------
1999 1998
----------- -----------
Cash flows from operating activities:
Net income $ 5,469 $ 2,895
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 8,571 4,035
Purchased research and development -- 6,090
Tax benefit from stock option transactions 777 2,958
Loss on disposal of property and equipment 141 --
Changes in assets and liabilities:
Accounts receivable, net (3,981) (8,573)
Other assets 1,379 (991)
Deferred income taxes 2,334 4,229
Accounts payable 2,948 (317)
Accrued liabilities (2,206) 2,502
Deferred revenue 569 203
Other liabilities 67 (217)
----------- -----------
Net cash provided by operating activities 16,068 12,814
----------- -----------
Cash flows from investing activities:
Purchases of investments (44,109) (99,030)
Maturities of investments 26,092 17,504
Proceeds from sale of investments 42,170 4,000
Investments in unconsolidated subsidiaries (11,720) --
Cash purchased in business acquisitions -- 649
Acquisitions, net of cash acquired -- (6,250)
Acquisitions of property and equipment (10,339) (3,399)
Proceeds from sale of property and equipment 184 --
----------- -----------
Net cash provided by (used in) investing activities 2,278 (86,526)
----------- -----------
Cash flows from financing activities:
Net proceeds from issuance of common stock 2,666 4,900
Purchase of treasury stock (50,381) --
Proceeds from issuance of Convertible Subordinated Notes -- 100,000
Debt issuance costs -- (2,933)
Repayment of bank line of credit -- (770)
Repayment of capital lease obligations (60) (105)
----------- -----------
Net cash (used in) provided by financing activities (47,775) 101,092
----------- -----------
Effect of exchange rate changes on cash (432) 2
----------- -----------
Net (decrease) increase in cash and cash equivalents (29,861) 27,382
Cash and cash equivalents at the beginning of the period 54,267 18,068
----------- -----------
Cash and cash equivalents at the end of the period $ 24,406 $ 45,450
=========== ===========
Supplemental cash flow disclosure:
Assets assumed in acquisitions of Retek Logistics, FTI, and ATACS $ -- $ 32,711
=========== ===========
Liabilities assumed in acquisitions of Retek Logistics, FTI, and
ATACS $ -- $ 7,297
=========== ===========
See accompanying notes to consolidated financial statements.
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HNC SOFTWARE INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
(in thousands)
(unaudited)
ACCUMULATED
OTHER
COMMON STOCK PAID-IN DEFERRED COMPREHENSIVE
SHARES AMOUNT CAPITAL COMPENSATION LOSS
----------- ----------- ----------- ----------- -------------
BALANCE AT DECEMBER 31, 1998 25,894 $ 26 $ 137,182 $ (2,508) $ (160)
Common stock options exercised 337 1,336
Common stock issued under
Employee Stock Purchase Plan 54 1,332
Tax benefit from stock option
transactions 777
Treasury stock (2,266) (2)
Unearned stock compensation
expense amortization 893
Additional shares issued to Retek
Logistics stockholders 45 1,011
Unrealized loss on investments (217)
Foreign currency translation
adjustment (432)
Net income
----------- ----------- ----------- ----------- -----------
BALANCE AT JUNE 30, 1999 24,064 $ 24 $ 141,638 $ (1,615) $ (809)
=========== =========== =========== =========== ===========
TOTAL
RETAINED TREASURY STOCKHOLDERS' COMPREHENSIVE
EARNINGS STOCK EQUITY INCOME
----------- ----------- ------------ --------------
BALANCE AT DECEMBER 31, 1998 $ 18,481 $ 153,021
Common stock options exercised 1,336
Common stock issued under
Employee Stock Purchase Plan 1,332
Tax benefit from stock option
transactions 777
Treasury stock $ (50,381) (50,383)
Unearned stock compensation
expense Amortization 893
Additional shares issued to Retek
Logistics Stockholders 1,011
Unrealized gain on investments (217) $ (217)
Foreign currency translation
adjustment (432) (432)
Net income 5,469 5,469 5,469
----------- ----------- ----------- -----------
BALANCE AT JUNE 30, 1999 $ 23,950 $ (50,381) $ 112,807 $ 4,820
=========== =========== =========== ===========
See accompanying notes to consolidated financial statements
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HNC SOFTWARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 GENERAL
In management's opinion, the accompanying unaudited consolidated
financial statements for HNC Software Inc. (the "Company") for the three and six
month periods ended June 30, 1999 and 1998 have been prepared in accordance with
generally accepted accounting principles for interim financial statements and
include all adjustments (consisting only of normal recurring accruals) that the
Company considers necessary for a fair presentation of its financial position,
results of operations, and cash flows for such periods. However, the
accompanying financial statements do not contain all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. All such financial statements are unaudited except the
December 31, 1998 balance sheet. This Report and the accompanying unaudited and
audited financial statements should be read in conjunction with the Company's
audited financial statements and notes thereto presented in its Annual Report on
Form 10-K for the fiscal year ended December 31, 1998 (the "1998 Annual
Report"). Footnotes which would substantially duplicate the disclosures in the
Company's audited financial statements for the fiscal year ended December 31,
1998 contained in the 1998 Annual Report have been omitted. The interim
financial information contained in this Report is not necessarily indicative of
the results to be expected for any other interim period or for the full fiscal
year ending December 31, 1999.
NOTE 2 BASIS OF PRESENTATION
The acquisition of Retek Logistics Inc. ("Retek Logistics"), formerly
Practical Control Systems Technologies, Inc., was completed on March 31, 1998
and accounted for as a purchase as of the acquisition date. The acquisition of
Financial Technology, Inc. ("FTI") was completed on April 7, 1998 and accounted
for as a purchase as of the acquisition date. In addition, the acquisition of
the Advanced Telecommunications Abuse Control System ("ATACS") product line of
Bedford Associates, Inc., which is a wholly owned subsidiary of British Airways
plc, was completed on June 11, 1998 and accounted for as a purchase as of that
date. In connection with the acquisitions of Retek Logistics, FTI and ATACS,
acquired in-process research and development of $1.8 million, $3.0 million and
$1.3 million, respectively, was charged to operations at the acquisition dates.
NOTE 3 INVESTMENTS
Investments in corporate entities with less than 20% voting interest are
generally accounted for under the cost method. On March 18, 1999, the Company
made a minority equity investment in AIM Solutions, Inc. ("AIM"), a company
which provides marketing process automation, campaign execution software, and
client-to-vendor data management to direct marketers of enhancement services.
The Company's total investment in AIM was $750,000. On March 31, 1999, the
Company made a minority equity investment in Qpass Inc. ("Qpass"), a web-wide
transaction and customer service network enabling commerce in digital goods and
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services. The Company's total investment in Qpass was $2.0 million. On April 16,
1999, the Company acquired a minority equity investment in Open Solutions Inc.
("OSI"), a developer of client/server core data processing solutions for
community banks and credit unions. The Company's total investment in OSI was
$6.0 million. On June 1, 1999, the Company acquired a minority equity investment
in ShopNow.com ("ShopNow"), an e-commerce company. Through its full suite of
e-commerce solutions, ShopNow helps customers and merchants safely and easily
buy and sell merchandise online. The Company's total investment in ShopNow was
$3.0 million. These investments are all being accounted for under the cost
method.
NOTE 4 RECONCILIATION OF NET INCOME AND SHARES USED IN PER SHARE COMPUTATIONS
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- --------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
(in thousands) (in thousands)
NET INCOME USED:
Net income used in computing
basic and diluted net income
per common share $ 3,345 $ 508 $ 5,469 $ 2,895
=========== =========== =========== ===========
SHARES USED:
Shares used in computing basic net
income per common share 24,498 25,290 25,078 24,987
Weighted average options to purchase
common stock as determined by
application of the treasury stock
method 450 1,304 576 1,354
Purchase Plan common stock
equivalents 52 95 52 95
----------- ----------- ----------- -----------
Shares used in computing diluted net
income per common share 25,000 26,689 25,706 26,436
=========== =========== =========== ===========
The conversion of the Company's 4.75% convertible subordinated notes for
the three and six month periods ended June 30, 1999 of 2,230,000 shares and the
three and six month periods ended June 30, 1998 of 2,230,000 and 1,319,000
shares, respectively, were not used to calculate diluted net income per share as
their effect would be anti-dilutive.
NOTE 5 TREASURY STOCK
During February 1999, the Company began acquiring shares of its common
stock in connection with a stock repurchase program announced in February 1999.
The program authorized the Company to purchase up to 700,000 of common shares
from time to time for cash at market prices in open market, negotiated or block
transactions. In April 1999, the Board of Directors authorized the Company to
repurchase up to an additional 10% of its outstanding common shares under
certain conditions from time to time for cash at market prices in open market,
negotiated or block transactions. The Company purchased 2,266,100 shares of
common
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stock in the first six months of 1999 at an average cost of $22.23 per share.
The purpose of the stock repurchase programs is to help cover the Company's
annual "evergreen" stock option grants, which provide continued incentives to
the Company's employees, and to further fund a reserve of shares for future
employee stock options grants.
NOTE 6 INCOME TAX PROVISION
The 1998 income tax provision includes the tax effects of the
non-deductible, one-time write-offs of in-process research and development
related to the purchases of Retek Logistics, FTI and ATACS. The 1999 income tax
provision includes the tax effects of non-deductible acquisition related
amortization expense.
NOTE 7 SEGMENT INFORMATION
The Company's reportable segments are those that are based on the
Company's method of internal reporting, which disaggregates its business by
product category. The Company's major segments are as follows: the Financial
Solutions Group ("FSG"), the Insurance Solutions Group ("ISG") and the Retail
Solutions Group ("RSG"). FSG's predictive customer relationship management
applications analyze data to retrieve the relationship intelligence that
financial institutions use to manage customer accounts. These solutions can be
used to segment customer profiles to perform one-to-one marketing, maximize
profitability, and manage risks such as fraud, bankruptcy, and delinquency. The
ISG segment provides a medical bill repricing system for workers' compensation
and auto liability and a suite of predictive technology-based products for
maximized management of claims throughout their lifecycle. Designed to analyze
large volumes of highly complex data efficiently, these solutions automate and
improve insurance claim and healthcare management decision-making. The RSG
segment offers a suite of enterprise-wide retail management solutions, which
assimilate information from a variety of sources to provide retailers with the
ability to predict the ever-changing behaviors of customers and to manage their
warehouse, inventory and supply chain processes. This includes increasing the
efficiency and reducing the costs of how retailers handle, track and optimize
the global flow of merchandise from the vendor through the warehouse, to the
stores, and finally on to customers. The remaining segments of HNC's business
operations, reflected in the "Other" category, develop, market and support
predictive software solutions for the Internet and telecommunication service
industries and provide research and development for United States government
contracts.
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The Company is organized on the basis of products and services. The
segments are strategic business units that offer different products and
services. The table below presents information about the reported revenues and
operating income of each segment, excluding all amortization and acquisition
related expenses, for the three and six months ended June 30, 1999 and 1998 (in
thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------- ---------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
Segment revenue:
FSG $ 16,357 $ 13,828 $ 30,556 $ 24,572
RSG 21,043 15,358 37,689 26,499
ISG 14,838 11,279 28,487 22,409
Other 3,695 2,976 8,390 5,342
Intersegment elimination -- (300) -- (600)
----------- ----------- ----------- -----------
Total consolidated revenue $ 55,933 $ 43,141 $ 105,122 $ 78,222
=========== =========== =========== ===========
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------- ----------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
Segment operating income (loss):
FSG $ 3,212 $ 2,976 $ 5,364 $ 4,997
RSG 3,233 3,266 6,309 5,376
ISG 2,721 1,737 3,426 4,019
Other (1,116) 443 (1,112) 779
----------- ----------- ----------- -----------
Total segment operating income 8,050 8,422 13,987 15,171
----------- ----------- ----------- -----------
Acquisition expense -- (428) -- (673)
In-process research and development -- (4,340) -- (6,090)
Acquisition related amortization (2,056) (806) (4,308) (806)
----------- ----------- ----------- -----------
Consolidated operating income 5,994 2,848 9,679 7,602
----------- ----------- ----------- -----------
Other (loss) income, net (17) 641 286 1,042
Minority interest in income of
consolidated subsidiary -- (38) -- (60)
----------- ----------- ----------- -----------
Income before income tax provision $ 5,977 $ 3,451 $ 9,965 $ 8,584
=========== =========== =========== ===========
Specified items included in segment operating income:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- -------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
Segment depreciation expense:
FSG $ 627 $ 639 $ 1,246 $ 1,238
RSG 552 309 992 547
ISG 467 359 971 708
Other 281 159 530 314
----------- ----------- ----------- -----------
Total segment depreciation expense $ 1,927 $ 1,466 $ 3,739 $ 2,807
=========== =========== =========== ===========
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The table below presents information about the reported assets of the
Company at June 30, 1999 and 1998.
JUNE 30,
-----------------------------
1999 1998
----------- -----------
Total segment assets:
FSG $ 38,236 $ 39,519
RSG 34,980 31,951
ISG 27,174 18,379
Other 13,510 15,403
----------- -----------
Total segment assets 113,900 105,252
----------- -----------
Corporate 154,432 216,682
Eliminations (24,325) (59,177)
----------- -----------
Total consolidated assets $ 244,007 $ 262,757
=========== ===========
Corporate assets are primarily comprised of cash, short-term and
long-term investments available for sale, deferred tax assets and intersegment
receivables. Eliminations primarily relate to intersegment receivables.
The following represents capital expenditures by segment for the three
and six months ended June 30, 1999 and 1998:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- --------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
Segment capital expenditures:
FSG $ 1,799 $ 623 $ 2,967 $ 1,308
RSG 828 374 2,755 1,106
ISG 923 581 3,277 891
Other 869 43 1,340 94
----------- ----------- ----------- -----------
Total capital expenditures $ 4,419 $ 1,621 $ 10,339 $ 3,399
=========== =========== =========== ===========
The following is revenue by geographic area for the three and six months
ended June 30, 1999 and 1998 and long-lived asset information by geographic area
at June 30, 1999:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------- ---------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
Revenue by geographic area:
United States $ 43,623 $ 33,217 $ 78,510 $ 56,232
Foreign 12,310 9,924 26,612 21,990
----------- ----------- ----------- -----------
Total revenue $ 55,933 $ 43,141 $ 105,122 $ 78,222
=========== =========== =========== ===========
JUNE 30,
--------------------------
1999 1998
----------- -----------
Long-lived assets by geographic area:
United States $ 45,482 $ 39,940
Foreign 137 312
----------- -----------
Total long-lived assets $ 45,619 $ 40,252
=========== ===========
The Company's foreign sales represent revenues from export sales and
international operations. Export sales include sales from the United States to
foreign countries. International operations include sales by foreign operations.
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HNC SOFTWARE INC.
Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENTS: NO ASSURANCES INTENDED
This Report (including the following section regarding Management's
Discussion and Analysis of Financial Condition and Results of Operations)
contains forward-looking statements regarding the Company and its business,
financial condition, results of operations and prospects. Words such as
"expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates"
and similar expressions or variations of such words are intended to identify
forward-looking statements, but are not the exclusive means of identifying
forward-looking statements in this Report. Additionally, statements concerning
future matters such as the development of new products, enhancements or
technologies, international sales, expense levels, possible changes in
legislation, year 2000 matters, the assumptions used in valuing in-process
research and development, the Company's capital needs and other statements
regarding matters that are not historical are forward-looking statements.
Although forward-looking statements in this Report reflect the good
faith judgment of the Company's management, such statements can only be based on
facts and factors currently known by the Company. Consequently, forward-looking
statements are inherently subject to risks and uncertainties and actual results
and outcomes may differ materially from the results and outcomes discussed in or
anticipated by the forward-looking statements. Factors that could cause or
contribute to such differences in results and outcomes include without
limitation those discussed in "Potential Fluctuations in Operating Results" as
well as those discussed elsewhere in this Report and those discussed in the
Company's 1998 Annual Report. Readers are urged not to place undue reliance on
these forward-looking statements, which speak only as of the date of this
Report. The Company undertakes no obligation to revise or update any
forward-looking statements in order to reflect any event or circumstance that
may arise after the date of this Report. Readers are urged to carefully review
and consider the various disclosures made by the Company in this Report, which
attempt to advise interested parties of the risks and factors that may affect
the Company's business, financial condition, results of operations and
prospects.
POTENTIAL FLUCTUATIONS IN OPERATING RESULTS
The Company's revenues and operating results have varied significantly
in the past and may do so in the future. Factors affecting the Company's
revenues and operating results include: market acceptance of the Company's
products; the relatively large size and small number of customer orders that may
be received during a given period; the timing of customer orders; customer
cancellation of long-term contracts that yield recurring revenues or customers'
ceasing their use of the Company's products for which the Company's fees are
usage based; the length of the sales cycle of the Company's products; the
Company's ability to develop, introduce and market new products and product
enhancements; competitive conditions in the industries served by the Company;
the timing of new product announcements and introductions by the Company and its
competitors; changes in the mix of the Company's distribution channels; changes
in the
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level of the Company's operating expenses; the Company's ability to achieve
progress on percentage-of-completion contracts; the Company's ability to
complete certain pilot installations within the contracted fee budget; potential
changes in the Company's relationships with, and strategies for, its business
segments; competitive conditions in the industry; domestic and international
economic conditions; market conditions in the Company's targeted markets and
costs of any pending litigation. In addition, license agreements entered into
during a quarter may not meet HNC's revenue recognition criteria. Therefore,
even if the Company meets or exceeds its forecast of aggregate licensing and
other contracting activity, it is possible that the Company's revenues would not
meet expectations. Furthermore, the Company's operating results may be affected
by factors unique to certain of its product lines. For example, the Company
derives a substantial and increasing portion of its revenues from its retail
products, which are generally priced as "perpetual" license transactions in
which the Company receives a one-time license fee. The Company recognizes these
fees as revenue upon delivery of the software and acceptance by the customer.
Thus, failure to complete a perpetual license transaction during a fiscal
quarter would preclude the Company from recognizing revenue from that
transaction in that quarter, and thus would have a disproportionate adverse
impact on the Company's operating results for that quarter.
The Company expects fluctuations in its operating results to continue
for the foreseeable future. Consequently, the Company believes that
period-to-period comparisons of its financial results should not be relied upon
as an indication of future performance. Because the Company's expense levels are
based in part on its expectations regarding future revenues and in the short
term are fixed to a large extent, the Company may be unable to adjust its
spending in time to compensate for any unexpected revenue shortfall.
Accordingly, the Company may not be able to maintain profitability on a
quarterly or annual basis in the future. Due to the foregoing factors, it is
possible that in some future quarter the Company's operating results will be
below the expectations of public market analysts and investors. In that event,
the price of the Company's Common Stock and, in turn, the price of the Company's
4.75% Convertible Subordinated Notes due 2003, would likely be materially
adversely affected.
RESULTS OF OPERATIONS
The Company develops, markets and supports predictive software solutions
for leading service industries, including financial, insurance and retail. These
predictive software solutions employ proprietary neural-network predictive
decision engines, profiles, traditional statistical modeling, business models,
expert rules and context vectors to convert existing data and business
experiences into meaningful recommendations and actions. The Company's major
segments are as follows: the Financial Solutions Group ("FSG"), the Insurance
Solutions Group ("ISG") and the Retail Solutions Group ("RSG"). FSG's predictive
customer relationship management applications analyze data to retrieve the
relationship intelligence that financial institutions use to manage customer
accounts. These solutions can be used to segment customer profiles to perform
one-to-one marketing, maximize profitability, and manage risks such as fraud,
bankruptcy, and delinquency. The ISG segment provides a medical bill repricing
system for workers' compensation and auto liability and a suite of predictive
technology-based products for maximized management of claims throughout their
lifecycle. Designed to analyze large volumes of highly complex data efficiently,
these solutions automate and improve insurance claim and healthcare management
decision-making. The RSG segment offers a suite of enterprise-wide
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retail management solutions, which assimilate information from a variety of
sources to provide retailers with the ability to predict the ever-changing
behaviors of customers and to manage their warehouse, inventory and supply chain
processes. This includes increasing the efficiency and reducing the costs of how
retailers handle, track and optimize the global flow of merchandise from the
vendor through the warehouse, to the stores, and finally on to customers. The
remaining segments of HNC's business operations develop, market and support
predictive software solutions for the Internet and telecommunication service
industries.
The Company's revenues are comprised of license and maintenance
revenues, and services and other revenues. The Company's revenues for the three
months ended June 30, 1999 were $55.9 million, an increase of 29.7% over
revenues of $43.1 million for the same period in the prior year. The Company's
revenues for the six months ended June 30, 1999 were $105.1 million, an increase
of 34.4% over revenues of $78.2 million for the same period in the prior year.
LICENSE AND MAINTENANCE REVENUES. The Company's license and maintenance
revenues are derived from annual license fees, monthly license fees, perpetual
license fees and annual maintenance fees. The Company licenses many of its
products for an annual or monthly usage fee under long-term contracts that
include software licenses, decision model updates, application consulting, and
on-line or on-site support and maintenance. The Company's revenues from periodic
software license and maintenance agreements are generally recognized ratably
over the respective license or agreement periods. Revenues from certain
short-term periodic software license and maintenance agreements with a
guaranteed minimum license fee are recognized as related services are performed.
Transactional fees are recognized as revenue based on system usage or when fees
based on system usage exceed the monthly minimum license fees. Revenues from
perpetual licenses of the Company's software for which there are no significant
continuing obligations and collection of the related receivables is probable are
recognized on delivery of the software and acceptance by the customer.
License and maintenance revenues were $41.3 million for the quarter
ended June 30, 1999, an increase of 22.3% from $33.8 million for the comparable
quarter in 1998. License and maintenance revenues were $77.8 million for the six
months ended June 30, 1999, an increase of 28.2% from $60.7 million for the
comparable period in 1998. License and maintenance revenues from the retail
solutions segment were $15.7 million for the quarter ended June 30, 1999, an
increase of 30.5% from $12.0 million for the comparable quarter in 1998. License
and maintenance revenues from the retail solutions segment were $27.3 million
for the six months ended June 30, 1999, an increase of 29.9% from $21.0 million
for the comparable period in 1998. The increase in the retail solutions segment
was attributable to an increase in sales of the Retek suite of products,
primarily the Retail Merchandising System. License and maintenance revenues from
the insurance solutions segment were $12.1 million for the quarter ended June
30, 1999, an increase of 33.9% from $9.0 million for the comparable quarter in
1998. License and maintenance revenues from the insurance solutions segment were
$24.0 million for the six months ended June 30, 1999, an increase of 33.1% from
$18.0 million for the comparable period in 1998. The increase in the insurance
solutions segment was primarily a result of an increase in revenues derived by
the COMPADVISOR (formerly CRLink) product. License and maintenance revenues from
the financial solutions segment were $11.0 million for the quarter ended June
30, 1999, a decrease of 2.0% from $11.2 million for the comparable quarter in
1998. The decrease in the financial solutions segment for this period was
attributable to decreases in license revenue
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from ProfitVision, an FTI product, the Capstone product, and AREAS (for which
the Company entered into a two year service agreement and a three year
sale/license agreement with TransAmerica Intellitech). This decrease was offset
by increases in license and maintenance revenue from the Falcon and ProfitMax
product lines. License and maintenance revenues from the financial solutions
segment were $20.7 million for the six months ended June 30, 1999, an increase
of 8.2% from $19.1 million for the comparable period in 1998. The increase in
the financial solutions segment for this period was attributable to increases in
license and maintenance revenue from the Falcon and ProfitMax product lines,
offset by a decrease in license revenue from AREAS.
SERVICES AND OTHER REVENUES. Services and other revenues are comprised
of installation and implementation revenues, service bureau operations revenues
and revenues which are derived from consulting contracts, new product
development contracts with commercial customers and, to a lesser extent,
research and development contracts with the United States government. Revenues
from installation and implementation services and contract services are
generally recognized as the services are performed using the percentage of
completion method based on costs incurred to date compared to total estimated
costs at completion. Service bureau revenues are derived from the Company's
service bureau operations, which provide COMPADVISOR's insurance claims review
functionality to customers that do not wish to obtain a license. These customers
use this service until they can implement their own internal COMPADVISOR
operation or use this service when their volumes peak to high levels. Service
bureau customers typically subscribe for services under month-to-month
agreements and service bureau fees are recognized as revenue when the processing
services are performed.
Services and other revenues were $14.6 million for the quarter ended
June 30, 1999, an increase of 56.2% from $9.3 million for the comparable quarter
in 1998. Services and other revenues were $27.3 million for the six months ended
June 30, 1999, an increase of 55.7% from $17.5 million for the comparable period
in 1998. Services and other revenues from the retail solutions segment were $5.4
million for the quarter ended June 30, 1999, an increase of 60.6% from $3.4
million for the comparable quarter in 1998. Services and other revenues from the
retail solutions segment were $10.4 million for the six months ended June 30,
1999, an increase of 89.9% from $5.5 million for the comparable period in 1998.
This increase was due to an increase in consulting contracts with commercial
customers as a result of an expanding customer base and an increase in the range
of services offered. Services and other revenues from the financial solutions
segment were $5.4 million for the quarter ended June 30, 1999, an increase of
104.2% from $2.6 million for the comparable quarter in 1998. Services and other
revenue from the financial solutions segment were $9.9 million for the six
months ended June 30, 1999, an increase of 81.2% from $5.4 million for the
comparable period in 1998. This increase was attributable to an increase in
implementations of the Capstone product, and to a lesser extent, installations
of the Falcon suite of products, offset in part by a decrease in installations
of the ProfitMax suite of products. Services and other revenues from the
insurance solutions segment were $2.7 million for the quarter ended June 30,
1999, an increase of 22.3% from $2.2 million for the comparable quarter in 1998.
This increase was primarily attributable to service bureau revenue generated
from a significant new customer to the insurance solutions segment, who began
using COMPADVISOR in March 1999, and to increased consulting revenues, offset in
part by the loss of a service bureau customer during the first quarter of 1999
due to industry consolidation. Services and other revenues from the insurance
solutions segment were $4.5
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million for the six months ended June 30, 1999, an increase of 2.5% from $4.4
million for the comparable period in 1998.
LICENSE AND MAINTENANCE GROSS MARGIN. License and maintenance costs
primarily represent the Company's expenses for personnel engaged in customer
support, travel to customer sites and preparation of documentation materials.
The Company's gross margin on license and maintenance revenues was 75.5% for the
second quarter of 1999 and 75.8% for the second quarter of 1998. The Company's
gross margin on license and maintenance revenues was 73.2% for the first six
months of 1999 and 76.7% for the first six months of 1998.
License and maintenance gross margin from the retail solutions segment
was 88.2% for the second quarter of 1999 and 86.7% for the second quarter of
1998. The increase was attributable to license revenue from the Retail
Merchandising System growing faster than associated costs. License and
maintenance gross margin from the retail solutions segment was 88.1% for the
first six months of 1999 and 89.4% for the first six months of 1998. The primary
reason for the decrease in gross margin from the retail solutions segment was an
increase in staffing and associated costs in client services to support the
increased volume of business, offset in part by the increased revenue from the
Retail Merchandising System. License and maintenance gross margin from the
insurance solutions segment was 50.2% for the second quarter of 1999 and 54.9%
for the second quarter of 1998. License and maintenance gross margin from the
insurance solutions segment was 45.3% for the first six months of 1999 and 57.2%
for the first six months of 1998. The decrease was attributable to the
COMPADVISOR and AUTOADVISOR products' Preferred Provider Organization bill
repricing expenses, such as network access fees, increasing at greater rate than
revenue, due to increasingly competitive conditions. The decrease was also
attributable, to a lesser extent, to an increase in the percentage of revenue
from Preferred Provider Organization bill repricing, which typically has lower
margins than the overall bill review business. License and maintenance gross
margin from the financial solutions segment was 83.0% for the second quarter of
1999 and 79.2% for the second quarter of 1998. License and maintenance gross
margin from the financial solutions segment was 81.9% for the first six months
of 1999 and 80.7% for the first six months of 1998. The increase in gross margin
from the financial solutions segment was the result of recurring license and
maintenance revenues growing faster than the associated costs to maintain this
revenue stream.
SERVICES AND OTHER GROSS MARGIN. Services and other expenses consist of
personnel and other expenses associated with providing installation and
implementation services and performing development, consulting, and research and
development contracts and the costs associated with the service bureau
operations. The Company's gross margin on services and other revenues was 29.3%
for the second quarter of 1999 and 26.3% for the second quarter of 1998. The
Company's gross margin on services and other revenues was 30.5% for the first
six months of 1999 and 33.6% for the first six months of 1998.
Services and other gross margin from the retail solutions segment was
15.0% for the second quarter of 1999 and 23.4% for the second quarter of 1998.
This decrease was attributable to significant increases in
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services staff to meet the customer demand for services work, as well as
increased costs related to the custom development projects. Services and other
gross margin from the retail solutions segment was 28.1% for the first six
months of 1999 and 29.5% for the first six months of 1998. This decrease was
attributable primarily to significant increases in services staff to meet the
customer demand for services work during the second quarter of 1999, offset in
part by decreased subcontracted labor during the first quarter of 1999. Services
and other gross margin from the financial solutions segment was 38.9% for the
second quarter of 1999 and 22.3% for the second quarter of 1998. Services and
other gross margin from the financial solutions segment was 36.3% for the first
six months of 1999 and 29.5% for the first six months of 1998. The increase in
the margins was the result of a change in the pricing of services for the
Capstone product from primarily fixed fee to time and materials pricing, as well
as an increase in the number of Falcon installations, which typically yield
higher margins. Services and other gross margin from the insurance solutions
segment was 35.3% for the second quarter of 1999 and 37.2% for the second
quarter of 1998. Services and other gross margin from the insurance solutions
segment was 20.8% for the first six months of 1999 and 42.8% for the first six
months of 1998. The decrease in the gross margins was the result of the loss of
one of the insurance solutions segment's service bureau customers during the
first quarter of 1999 due to industry consolidation and the continuation of
employee staffing at the prior quarter's levels. Gross margin improved for the
insurance solutions segment in the second quarter of 1999 due to revenue from a
new service bureau customer, who began using COMPADVISOR in March 1999, but were
lower than second quarter 1998 due primarily to increased service bureau
staffing.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
consist primarily of salaries and other personnel-related expenses,
subcontracted development services, depreciation for development equipment and
supplies. Research and development expenses in the second quarter of 1999 were
$11.6 million or 20.8% of total revenues compared to $7.6 million or 17.6% of
total revenues in the second quarter of the prior year. Research and development
expenses in the first six months of 1999 were $21.1 million or 20.1% of total
revenues compared to $14.5 million or 18.5% of total revenues in the first six
months of 1998.
The retail solutions segment accounted for approximately $5.5 million
and $2.8 million during the quarters ended June 30, 1999 and 1998, respectively,
and accounted for approximately $9.7 million and $5.4 million of research and
development expenses during the six months ended June 30, 1999 and 1998,
respectively. The financial solutions segment accounted for approximately $3.0
million and $2.5 million during the quarters ended June 30, 1999 and 1998,
respectively, and accounted for approximately $5.6 million and $4.8 million of
research and development expenses during the six months ended June 30, 1999 and
1998, respectively. The insurance solutions segment accounted for approximately
$1.9 million and $1.7 million during the quarters ended June 30, 1999 and 1998,
respectively, and accounted for approximately $3.7 million and $3.2 million of
research and development during the six months ended June 30, 1999 and 1998,
respectively. The increase in these expenses in absolute dollars was due
primarily to increases in staffing and related costs to support increased
product development activities, including product enhancements and the
development of new products in the retail solutions segment and, to a lesser
extent, product enhancements in the financial solutions and insurance solutions
segments.
Statement of Financial Accounting Standards No. 86, "Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed," requires
capitalization of certain software development costs subsequent to the
establishment of technological feasibility. Based on the Company's product
development process, technological feasibility is not established until
completion of a working model. Costs incurred by the Company between completion
of the
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working model and the point at which a product is ready for general release have
been insignificant. As a result, no significant software development costs were
capitalized through June 30, 1999. The Company anticipates that research and
development expenses will increase in dollar amount and could increase as a
percentage of total revenues for the foreseeable future.
SALES AND MARKETING EXPENSES. Sales and marketing expenses consist
primarily of salaries and benefits, commissions, travel, entertainment and
promotional expenses. Sales and marketing expenses were $10.8 million or 19.2%
of total revenues in the second quarter of 1999 compared to $8.8 million or
20.4% of total revenues in the second quarter of 1998. Sales and marketing
expenses were $20.5 million or 19.5% of total revenues in the first six months
of 1999 compared to $16.4 million or 21.0% of total revenues in the first six
months of 1998. The retail solutions segment accounted for approximately $4.6
million and $3.6 million of sales and marketing expenses during the quarters
ended June 30, 1999 and 1998, respectively, and accounted for approximately $8.4
million and $6.9 million during the six months ended June 30, 1999 and 1998,
respectively. The financial solutions segment accounted for approximately $3.6
million and $3.2 million of sales and marketing expenses during the quarters
ended June 30, 1999 and 1998, respectively, and accounted for approximately $7.0
million and $5.7 million during the six months ended June 30, 1999 and 1998,
respectively. The insurance solutions segment accounted for approximately $1.0
million and $1.3 million of sales and marketing expenses during the quarters
ended June 30, 1999 and 1998, respectively, and accounted for approximately $2.0
million and $2.6 million during the six months ended June 30, 1999 and 1998,
respectively.
The increases in sales and marketing expenses were due primarily to
increases in staffing related to the retail solutions and financial solutions
segments' expansion of their direct sales and marketing staffs. Contributing to
the increases were increased expenses for trade shows, advertising, corporate
marketing programs and other expenses to support the recently acquired
businesses. The decrease in sales and marketing expenses in the insurance
solutions segment was attributable to downsizing the sales and marketing staff
late in the second quarter of 1998 due to the merger of the segment's two
insurance business units. The Company expects sales and marketing expenses
(including the insurance segment's sales and marketing expenses) to continue to
increase for the foreseeable future. Such expenses could also increase as a
percentage of total revenues as the Company invests in marketing for its
Internet solutions business and continues to develop a direct sales force in
Europe and other international markets, expand its domestic sales and marketing
organizations and increase the breadth of its product lines.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
consist primarily of personnel costs for finance, contract administration, human
resources and general management, as well as acquisition, insurance and
professional services expenses. General and administrative expenses were $5.1
million or 9.1% of total revenues in the second quarter of 1999, compared to
$3.7 million or 8.5% of total revenues in the second quarter of the prior year.
Included in general and administrative expenses were acquisition costs of
$428,000 for the three month period ended June 30, 1998. General and
administrative expenses were $9.6 million or 9.2% of total revenues in the first
six months of 1999 compared to $7.0 million or 9.0% of total revenues in the
first six months of 1998. Included in general and administrative expenses were
acquisition costs of $673,000 for the six-month period ended June 30, 1998.
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Excluding acquisition costs, the financial solutions segment accounted
for approximately $1.3 million and $840,000 of general and administrative
expenses during the quarters ended June 30, 1999 and 1998, respectively, and
accounted for approximately $2.6 million and $1.6 million during the first six
months of 1999 and 1998, respectively. Excluding acquisition costs, the retail
solutions segment accounted for approximately $1.4 million and $1.2 million of
general and administrative expenses during the quarters ended June 30, 1999 and
1998, respectively, accounted for approximately $2.6 million and $2.1 million
during the first six months of 1999 and 1998, respectively. Excluding
acquisition costs, the insurance solutions segment accounted for approximately
$1.4 million and $1.1 million of general and administrative expenses during the
quarters ended June 30, 1999 and 1998, respectively, and accounted for
approximately $2.7 million and $2.2 million during the first six months of 1999
and 1998, respectively. The increase in absolute dollars was due primarily to
increased staffing and related expenses to support higher levels of sales and
development activity across the Company resulting in part from the Company's
recent acquisitions. Contributing to the increase were legal costs incurred in
defending the Company from the complaint filed by Nestor in November 1998. The
Company believes the complaint is without merit and that the Company has good
and valid defenses to Nestor's claims. The Company intends to continue to defend
the action vigorously.
IN-PROCESS RESEARCH AND DEVELOPMENT EXPENSES. In-process research and
development expenses were $4.3 million or 10.1% of total revenues in the second
quarter of 1998 and $6.1 million or 7.8% of total revenues in the first six
months of 1998. These one-time write-offs were related to the acquisitions of
Retek Logistics and FTI and the asset purchase of ATACS.
Retek Logistics Inc. Retek Logistics is a supplier of fully
integrated distribution center management software products that address
the distribution needs of the retail, wholesale and manufacturing
industries. Retek Logistics' products may be classified into two
categories: Nautilus, an off-the-shelf warehouse management software
system designed to provide the tools needed to control the course of
warehouse operations and Nautilus CBT, an operational tutorial database
which guides the user through Nautilus operations. Certain products were
complete in certain areas and under development in others. The
classification of the technology as complete or under development was
made in accordance with the guidelines of Statement of Financial
Accounting Standards No. 86 ("SFAS 86"), Statement of Financial
Accounting Standards No. 2 ("SFAS 2") and Financial Accounting Standards
Board Interpretation No. 4 ("FIN4"). At the time of acquisition, Retek
Logistics had a number of new software products under development,
including Nautilus Versions 6.0 and 7.0 and Nautilus CBT. Nautilus
Version 6.0 and Nautilus CBT were both completed during 1998. Nautilus
7.0 was in an early stage of development as of the acquisition date and
was completed during the second quarter of 1999, incurring costs of
approximately $900,000 through to technological feasibility.
Financial Technology, Inc. FTI has been a provider of management
accounting software for financial institutions since 1982. FTI focuses
on principally three product categories: Profitability Measurement
Products; Decision Support Products; and Financial Platform Products.
FTI had various new products under development in each of these
categories, none of which had reached technological feasibility as of
the acquisition date. The classification of each new technology as
complete or under development was made in accordance with the guidelines
of SFAS 86, SFAS 2 and FIN4. Each new product under development has
varying release dates for completion ranging from July 1998 through
December 1999. The valuation
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of in-process research and development was based on the assumption that
the estimated cost to complete all products under development, measured
as of the acquisition date, was approximately $2.1 million, of which
$1.2 million would be incurred through December 1998 and an additional
$900,000 would be incurred during 1999. The valuation approach also
assumed that these products would generate revenues through the year
2002. During the second quarter of 1999, the Company implemented a
re-structuring of the FTI organization and revised the product roll out
schedules within each product category. As a consequence, some new
products under development were accelerated, some were delayed and some
were postponed, although the total expected expenditure remains
approximately the same as anticipated. Research and development costs
incurred from the date of acquisition through the second quarter of 1999
on all products under development were $1.4 million. These statements
regarding revenues and expenses are forward-looking statements, which
are subject to risks and uncertainties. Actual results may differ
materially from those anticipated. The important factors that could
cause actual results to differ include those discussed elsewhere in this
Report and in the Company's 1998 Annual Report. The inability of HNC to
complete this technology within the expected timeframes could materially
impact future revenues and earnings, which could have a material adverse
effect on HNC's business, financial condition and results of operations.
ATACS. ATACS is a fraud management software solution for the
wireline, wireless and Internet telecommunication service provider
industries. The system detects fraudulent traffic thereby avoiding
significant financial losses to traditional telecommunication carriers
and Internet Service Providers. ATACS' Version 4.2 includes significant
enhanced features from its prior version, including new enhancements to
Velocity, Message Handlers and a subsystem to support fraud detection of
on-line transactions. ATACS Version 4.1 was completed and producing
revenues prior to the acquisition date while Version 4.2, which includes
new technology that allows the system to function on three interface
platforms, was under development and had not yet reached technological
feasibility as of the acquisition date. Although Version 4.2 has as its
foundation technology from the completed as well as in-process
technology, HNC believes that it will have changed significantly so as
to be considered new research and development efforts. The
classification of each research and development project as complete or
under development was made in accordance with the guidelines of SFAS 86,
SFAS 2 and FIN4. ATACS Version 4.2 was released in July 1998, incurring
costs of approximately $250,000 to reach technological feasibility.
Valuation Approach. HNC used an independent appraisal firm to
assist it with its valuation of the fair market value of the purchased
assets of Retek Logistics, FTI and ATACS. Fair market value is defined
as the estimated amount at which an asset might be expected to be
exchanged between a willing buyer and willing seller assuming the buyer
continues to use the assets in its current operations. HNC provided
assumptions by product line of revenue, cost of goods sold and operating
expense to the appraiser to assist in the valuation. The appraisal
considered three traditional approaches to valuation: the cost approach,
the market approach and the income approach.
Retek Logistics Inc. With respect to the forecasted earnings
provided to the appraiser, Retek Logistics is forecasting slightly
higher revenue growth rates as long as it can continue to meet market
demands with new releases each year. These higher growth rates reflect
Retek Logistics' expectation of greater market acceptance with the
release of its ORACLE-based
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platform, as well as improvements incorporated into Nautilus versions 6
and 7. Retek Logistics' gross margins are forecasted to remain
consistent relative to prior years. Retek Logistics is also expecting
its current operating expense levels to increase only moderately in
absolute dollars and, as a result, earnings before interest and taxes
are expected to increase in later years. Management believes these
growth expectations are reasonable if new product versions are offered
according to schedule. The statements regarding expectations for Retek
Logistics are forward-looking statements, which are subject to risks and
uncertainties. Actual results may differ materially from those
anticipated. The important factors that could cause actual results to
differ include those discussed elsewhere in this Report and in the
Company's 1998 Annual Report.
Financial Technology Inc. Prior to 1997, FTI primarily sold
financial reporting general ledger software to mid-sized banks. During
1997, FTI began to derive a significant amount of its revenue from
ProfitVision, a customer profitability system for these same financial
institutions. With respect to the forecasted earnings provided to the
appraiser, FTI was forecasting significant revenue growth from a full
line of new software measurement tools. The financial forecasts
reflected in the appraiser's report reflected management's expectation
of significant revenue growth from a number of new product offerings.
Operating margins (before interest and taxes) were expected to increase
from historical trends. Management currently believes that these
projected increases will be delayed due to re-structuring the
organization and revision of the product roll out schedules. The
statements regarding expectations for FTI are forward-looking
statements, which are subject to risks and uncertainties. Actual results
may differ materially from those anticipated. The important factors that
could cause actual results to differ include those discussed elsewhere
in this Report and in the Company's 1998 Annual Report.
ATACS. ATACS represented a product line within Bedford
Associates, Inc. since 1995. Management was provided with limited
historical information but in conjunction with the acquisition, reviewed
contracts that supported revenue. The Company identified and ultimately
hired the development and support team that represents the underlying
costs of revenue as well as development costs. Under Bedford, ATACS was
not an aggressively marketed product and, as a result, sales growth
slowed and margins dropped slightly. The product becomes more widely
marketable with the offering of Version 4.2, which expands the
functionality to three new operating environments. With respect to the
forecasted earnings provided to the appraiser, the forecasts reflected
higher growth rates than prior years' ranges, reflecting the new product
offering and several years of prior marketing of the product now
generating sales opportunities. Gross margins are also forecasted to
increase rather significantly reflecting higher revenue levels and
economies of scale in the production and support cost areas. The
statements regarding expectations for ATACS are forward-looking
statements, which are subject to risks and uncertainties. Actual results
may differ materially from those anticipated. The important factors that
could cause actual results to differ include those discussed elsewhere
in this Report and in the Company's 1998 Annual Report.
With respect to the discount rates used in the valuation
approach, the incomplete technology represents a mix of near and
mid-term prospects for the business and imparts a level of uncertainty
to its prospects. It is the nature of the business to be constantly
developing new software for future product releases. A reasonable
expectation of return on the incomplete technology would be higher than
that of completed technology due to these
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inherent risks. As a result, the earnings associated with incomplete
technology were discounted at a rate of 40.0%, 27.0% and 22.5% for Retek
Logistics, FTI and ATACS, respectively, based upon the following
methodologies:
Retek Logistics Inc. Because Retek Logistics did not have
short-term or long-term debt as of the date of acquisition, the Moody's
seasoned Baa rate for March 31, 1998 was utilized as the cost of debt.
The Capital Asset Pricing Model was used to determine the cost of
equity. It combines a risk free rate of return with an equity risk
premium multiplied by a factor, referred to as Beta, which is based on
the performance of common stock prices of similar publicly traded
companies. Employing these data, the discount rate attributable to the
business was 30%, which was used for valuing completed technology. Since
incomplete technology represents a mix of near and mid-term prospects
for the business and imparts a certain level of uncertainty and would
require a higher return than completed technology, the valuation report
prepared by the Company's appraiser suggests that a rate of 40% be
ascribed to the excess earnings of incomplete technology.
Financial Technology Inc. The cash flows attributable to FTI's
technology were discounted based on a weighted average cost of capital
("WACC") analysis attributable to the business. In determining an
appropriate discount rate utilizing the WACC analysis, an analysis was
made of short-term interest rates, the yields of long-term corporate and
government bonds, and other alternative investment instruments, as well
as the typical capital structure of companies in the industry. Employing
this formula, the discount rate attributed to the business was 17%,
which was used to discount the completed technology. Incomplete
technology represents a mix of near- and mid-term prospects for the
business and imparts a certain level of uncertainty. The valuation
report prepared by the Company's appraiser suggests that a rate of 27%
be ascribed to the excess earnings of incomplete technology.
ATACS. Because ATACS did not have short-term or long-term debt
as of the date of acquisition, the Moody's seasoned Baa rate for May 19,
1998 was utilized as the cost of debt. The Capital Asset Pricing Model
was used to determine the cost of equity. It combines a risk free rate
of return with an equity risk premium multiplied by a factor, referred
to as Beta, which is based on the performance of common stock prices of
similar publicly traded companies. Employing these data, the discount
rate attributable to the business was 17.5%, which was used for valuing
completed technology. Since incomplete technology represents a mix of
near- and mid-term prospects for the business and imparts a certain
level of uncertainty and would require a higher return than completed
technology, the valuation report prepared by the Company's appraiser
suggests that a rate of 22.5% be ascribed to the excess earnings of
incomplete technology.
ACQUISITION RELATED AMORTIZATION EXPENSES. Acquisition related
amortization expenses were $2.1 million or 3.7% of total revenues in the second
quarter of 1999 and $806,000 or 1.9% of total revenues in the second quarter of
1998. Acquisition related amortization expenses were $4.3 million or 4.1% of
total revenues in the first six months of 1999 and $806,000 or 1.0% of total
revenues in the first six months of 1998. These expenses primarily represent the
amortization of intangible assets purchased in conjunction with the Company's
1998 acquisitions of Retek Logistics and FTI, the asset purchase of ATACS and
the acquisition of the minority interest of Aptex, which was previously a
majority-owned subsidiary. The average amortization life is approximately 4
years.
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OPERATING INCOME. The above factors resulted in operating income of $6.0
million in the second quarter of 1999, constituting 10.7% of total revenues in
the same period, and operating income of $2.8 million in the second quarter of
1998, constituting 6.6% of total revenues in the same period. Operating income
in the first six months of 1999 was $9.7 million, constituting 9.2% of total
revenues in the same period, and operating income in the first six months of
1998 was $7.6 million, constituting 9.7% of total revenues in the same period.
OTHER (LOSS) INCOME, NET. Other loss for the second quarter of 1999 was
$17,000 compared to other income of $641,000 in the second quarter of the prior
year. Other income for the first six months of 1999 was $286,000 compared to
other income of $1.0 million in the first six months of 1998. Other income is
comprised of interest income earned on cash and investment balances, net of
interest expense related to the 4.75% Convertible Subordinated Notes due 2003
(the "Notes"). HNC issued the Notes in February 1998. These decreases in other
income were attributable primarily to a decrease in interest income as a result
of lower cash and investment balances. During the first six months of 1999, the
Company repurchased 2.3 million Common Shares for $50.4 million. Contributing to
the decrease in other income from the first six months of 1998 compared to the
first six months of 1999 was a full quarter of interest expense related to the
Notes in the first quarter of 1999 as compared to the same period in the prior
year. This was partially offset by an increase in interest income related to the
investment of the proceeds from the public offering in March 1998 of $100
million related to the Notes.
INCOME TAX PROVISION. The income tax provision was $2.6 million in the
second quarter of 1999 and $2.9 million in the second quarter of 1998. The
income tax provision was $4.5 million in the first six months of 1999 and $5.7
million in the first six months of 1998. These provisions are based on
management's estimates of the effective tax rates to be incurred by the Company
during those respective full fiscal years. The 1998 income tax provision
includes the tax effects of the non-deductible, one-time write-offs of
in-process research and development related to the purchases of Retek Logistics
and FTI and the asset purchase of ATACS. The 1999 income tax provision includes
the tax effects of non-deductible acquisition related amortization expense.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities during the first six months of
1999 was $16.1 million, which included net income before depreciation and
amortization of approximately $14.0 million. Cash was further increased by
decreases in deferred income taxes of $2.3 million and other assets of $1.4
million and increases in accounts payable of $2.9 million, offset by an increase
in accounts receivable of $4.0 million and decrease in accrued liabilities of
$2.2 million. Net cash used in investing activities was $2.2 million during the
first six months of 1999, primarily due to purchases of investments available
for sale of $44.1 million, offset by $26.1 million of maturities and $42.2
million of proceeds from the sales of investments available for sale.
Contributing to the increase were acquisitions of property and equipment of
$10.2 million, including expansions into new facilities by the financial
solutions, insurance solutions and retail solutions segments, and acquisitions
of minority equity investments of $11.7 million during the first
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six months of 1999. Net cash used by financing activities of $47.8 million
during the first six months of 1999 was primarily related to the purchase of
treasury stock of $50.4 million offset by net proceeds of $2.7 million from the
issuance of common stock.
At June 30, 1999, the Company had $99.0 million in cash, cash
equivalents and investments. The Company believes that its current cash, cash
equivalents and investments available for sale balances, borrowings under its
credit facility and net cash provided by operating activities, will be
sufficient to meet its working capital and capital expenditure requirements for
at least the next 12 months. The Company expects to invest approximately $15.1
million in capital assets, including computer equipment and building
improvements during 1999. Management intends to invest the Company's cash in
excess of current operating requirements in short-term, interest-bearing,
investment-grade securities. A portion of the Company's cash could also be used
to acquire or invest in complementary businesses or products or otherwise to
obtain the right to use complementary technologies or data. From time to time,
in the ordinary course of business, the Company evaluates potential acquisitions
of such businesses, products, technologies or data. The Company has no present
understandings, commitments or agreements with respect to any material
acquisition of businesses, products, technologies or data.
In May 1999, the Company and Qpass entered into a joint venture
agreement pursuant to which each company obtained a 50% ownership interest in
the newly formed entity, Selectpass Systems LLC, a limited liability company
("Selectpass"). Selectpass was formed to develop real-time point-of-sale
services for online commerce which will provide speed and convenience to online
shoppers. The initial product, Power Wallet, manages online receipts and keeps
track of site-specific user names, secure passwords and other shopping
preferences. The Company is required to provide $1.0 million in funding and
could be required to provide an additional $2.0 million in funding through May
2024.
YEAR 2000 COMPLIANCE
GENERAL
It is generally anticipated that many organizations will experience
operational difficulties at the beginning of the Year 2000 as a result of the
fact that many currently installed computer systems and software products are
coded to accept only two digit entries in the date code field. Significant
uncertainty exists in the software and other industries concerning the scope and
magnitude of problems associated with the century change. As early as 1997, the
Company had begun the process of planning and updating, in some cases, its
earlier versions of existing software products. More recent versions of these
same products as well as new products were developed with Year 2000 date
processing in mind. To track performance of completing any remaining compliance
work as well as to assess the Year 2000 issue more broadly, the Company
developed a Year 2000 project plan.
PROJECT
The Company initiated a company-wide Year 2000 Project (Y2k Project)
during 1998 to more formally monitor compliance of its year 2000 exposure for
each major business unit and has divided the project into three major sections
that address its critical date sensitive components: software products,
information technology ("IT") infrastructure, and non-IT systems. The Y2k
Project consists of (1) assessing the current state of readiness for all
critical components, (2) developing project plans that track the status of work
performed toward completing planned solutions and (3) developing contingency
plans.
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In August 1998, IT directors of all significant business units were
asked to inventory all major components and provide the current state of
readiness as well as an indication as to when readiness would otherwise be
expected. In addition, each major business unit was asked to provide project
plan status reports that indicate how compliance would be achieved, as well as
to quantify the extent and timing of the effort and to identify when testing of
the solution would be completed. Finally, each major business unit was asked to
consider various scenarios that might impact successful implementation of their
Year 2000 solutions and to develop alternative or back-up plans to mitigate the
risk of not being ready on time.
CURRENT STATUS
The Company completed the initial stage of its Y2k Project during 1998
by taking inventory of its more major software products, identifying the state
of readiness for each and developing project plans for completing and
implementing designed solutions. Based on the Company's assessment of its major
software products, the Company believes that the current version of each is Year
2000 compliant. However, there can be no assurance that all of the Company's
customers will install the Year 2000 compliant version of the Company's products
in a timely manner, which could lead to failure of customer systems and product
liability claims against the Company.
The Company has also substantially completed its review of major non-IT
system components for Year 2000 compliance and has substantially completed
appropriate repair or replace actions based on the results of the review. Non-IT
systems include hardware and other electronic systems, excluding application
systems, used in operations of the Company's business. In general, the Company
relies on manufacturer's recommendations, certifications and warranties as
validation of Year 2000 compliance.
The Company's plan for the Year 2000 calls for compliance verification
of third parties supplying software and information systems to the Company for
both IT and non-IT systems and communication with significant suppliers to
determine the readiness of third parties' remediation of their own Year 2000
issues. As part of its assessment, the Company has substantially completed its
evaluation of the level of validation it will require of third parties to ensure
their Year 2000 readiness and has substantially completed appropriate repair or
replace activities. To date, the Company has not encountered any material Year
2000 issues concerning its computer systems.
Potential worst case Year 2000 scenarios currently being considered by
the Company address issues arising from non-compliance by its customers,
suppliers or internal operating systems. Although the Company's Y2k Project will
strive to uncover significant non-compliance issues, in the worst case not all
Y2k problems may be uncovered by the year 2000, which could have a material
adverse effect on the Company's business. However, the Company believes that its
most probable worst case scenario is more likely to arise from its customers'
and vendors' inability to become Year 2000 compliant than from the Company's
failure to bring its own products into compliance. As a result, the Company's
supply chain and revenues could be adversely impacted. As discussed below, the
Company generates a significant portion of its revenues from usage-based license
fees which would be at risk if its customers are unable to operate their
computer systems due to Year 2000 problems caused by software developed
internally by the customer or purchased from a third party vendor. Some
considerations include quantifying the impact that usage-based fees may have on
the Company's business and
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understanding the compliance programs and contingency plans, if any, the
Company's vendors and customers have developed.
COSTS
All costs associated with carrying out the Company's plan for the Year
2000 compliance are being expensed as incurred. The total cost associated with
preparation for the Year 2000 has not been, and is not expected to be, material
to the Company's business, financial condition or results of operations.
Nevertheless, the Company may not timely identify and remediate all significant
Year 2000 problems and remedial efforts may involve significant time and
expense. Failure to identify such problems could, for example, impair the
Company's internal product development efforts and internal management systems.
There can be no assurance that any Year 2000 compliance problems of the Company
or its customers or suppliers will not have a material adverse effect on the
Company's business, financial condition and results of operations.
RISKS
The inability of the Company to complete its assessment and any
necessary modifications to recently acquired products could have a material
adverse effect on the Company's business, financial condition and results of
operations. Even if the Company's products are Year 2000 compliant, the Company
may in the future be subject to claims based on Year 2000 issues in the products
of other companies, or issues arising from the integration of multiple products
within a system. The costs of defending and resolving Year 2000-related
disputes, and any liability of the Company for Year 2000 related damages,
including consequential damages, could have a material adverse effect on the
Company's business, financial condition and results of operations. Further, the
Company's products are generally used with enterprise systems involving complex
software products developed by other vendors, which may not be Year 2000
compliant. In particular, many of the Company's customers are financial
institutions, insurance companies and other companies with insurance and
financial services businesses, all of which use legacy computer systems that are
expected to be particularly susceptible to Year 2000 compliance issues. If the
Company's customers are unable to use their information systems because of the
failure of such non-compliant systems or software or for any other reason, there
would be a decrease in the volume of transactions that the Company's customers
process using the Company's products. As a result, the Company's recurring
revenue in the form of usage-based transactional fees from customers in the
insurance and financial solutions markets would decline, which would have a
material adverse effect on the Company's business, financial condition and
results of operations. Such failure could also affect the perceived performance
of the Company's products, which could have a negative effect on the Company's
competitive position. In addition, the Company believes that the purchasing
patterns of customers and potential customers may be affected by Year 2000
issues as companies expend significant resources to correct or patch their
current software systems for Year 2000 compliance. These expenditures may result
in reduced funds available to purchase software products such as those offered
by the Company, which could result in a material adverse effect on the Company's
business, financial condition and results of operations.
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Item 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to a variety of risks, including foreign currency
fluctuations and changes in the market value of its investments. In the normal
course of business, the Company employs established policies and procedures to
manage its exposure to fluctuations in foreign currency values and changes in
the market value of its investments.
The Company's foreign currency risks are mitigated principally by
contracting primarily in US dollars and maintaining only nominal foreign
currency cash balances. Working funds necessary to facilitate the short term
operations of the Company's subsidiaries are kept in the local currencies in
which they do business, with excess funds transferred to the Company's offices
in the United States for investment. For the three and six month periods ended
June 30, 1999, respectively, approximately 1.3% and 7.2% of the Company's sales
were denominated in currencies other than the Company's functional currency,
which is the US dollar. These foreign currencies are primarily those of Western
Europe, Canada and Australia.
The fair value of the Company's investments available for sale at June
30, 1999 was $74.6 million. The objectives of the Company's investment policy
are the safety and preservation of invested funds and liquidity of investments
that is sufficient to meet cash flow requirements. The Company's policy is to
place its cash, cash equivalents and investments available for sale with large
financial institutions and commercial companies and government agencies in order
to limit the amount of credit exposure. It is also the Company's policy to
maintain certain concentration limits and to invest only in certain "allowable
securities" as determined by the Company's management. The Company's investment
policy also provides that its investment portfolio must not have an average
portfolio maturity of beyond one year and that the Company must maintain certain
liquidity positions. Investments are prohibited in certain industries and
speculative activities. Investments must be denominated in U.S. dollars.
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PART II - OTHER INFORMATION
Item 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its 1999 Annual Meeting of Stockholders on May 20, 1999
(the "Annual Meeting"). At the Annual Meeting, the Company's stockholders
elected the Company's Board of Directors and approved the proposals described
more fully below. Proxies were solicited by the Company pursuant to Regulation
14A under the Securities and Exchange Act of 1934, as amended.
As of March 26, 1999, the record date for the Annual Meeting, there were
approximately 25,350,906 shares of the Company's Common Stock outstanding and
entitled to vote, of which 22,192,573 shares were present in person or by proxy
at the Annual Meeting. The directors of the Company who were elected at the
Annual Meeting were: Edward K. Chandler; Thomas F. Farb; Alex W. Hart; Charles
H. Gaylord, Jr. and Robert L. North.
The proposals considered at the Annual Meeting were voted on as follows:
1. Election of Directors. Proposal to elect five directors of the Company,
each to serve until the next Annual Meeting of Stockholders and until
his successor has been elected and qualified or until his earlier
resignation, death or removal.
VOTES FOR VOTES WITHHELD
--------- --------------
Nominees
Edward K. Chandler 22,104,345 88,228
Thomas F. Farb 22,102,933 89,640
Alex W. Hart 22,102,080 90,493
Charles H. Gaylord, Jr. 22,103,692 88,881
Robert L. North 22,102,055 90,518
2. Amendment to the 1995 Equity Incentive Plan. Proposal to amend the
Company's 1995 Equity Incentive Plan to increase the number of shares of
the Company's Common Stock reserved for issuance thereunder by 2,000,000
shares.
VOTES FOR VOTES AGAINST ABSTENTIONS BROKER NON-VOTE
--------- ------------- ----------- ---------------
14,321,469 3,770,787 24,419 4,075,898
3. Amendment to the 1995 Employee Stock Purchase Plan. Proposal to amend
the Company's 1995 Employee Stock Purchase Plan to increase the number
of shares of the Company's Common Stock reserved for issuance thereunder
by 250,000 shares.
VOTES FOR VOTES AGAINST ABSTENTIONS BROKER NON-VOTE
--------- ------------- ----------- ---------------
17,015,910 1,075,081 25,684 4,075,898
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4. Amendment to the 1995 Directors Stock Option Plan. Proposal to amend the
1995 Directors Stock Option Plan to increase the number of shares of the
Company's Common Stock reserved for issuance thereunder by 200,000
shares.
VOTES FOR VOTES AGAINST ABSTENTIONS BROKER NON-VOTE
--------- ------------- ----------- ---------------
14,741,242 3,343,369 32,064 4,075,898
5. Ratification of Auditors. Proposal to ratify the selection of
PricewaterhouseCoopers LLP as the Company's independent accountants for
the fiscal year ending December 31, 1999.
VOTES FOR VOTES AGAINST ABSTENTIONS
--------- ------------- -----------
22,153,083 22,413 17,077
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Item 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.01 Registrant's 1995 Directors Stock Option Plan and related
documents, as amended June 12, 1999.
27.01 Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended June 30,
1999.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report on Form 10-Q to be signed on its behalf
by the undersigned thereunto duly authorized.
HNC SOFTWARE INC.
Date: August 13, 1999 By: /s/ Raymond V. Thomas
---------------------------------------
Raymond V. Thomas
Vice President, Finance & Administration and
Chief Financial Officer
(for Registrant as duly authorized officer and as
Principal Financial Officer)
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EXHIBIT INDEX
Exhibits
--------
10.01 Registrant's 1995 Directors Stock Option Plan and related
documents, as amended June 12, 1999.
27.01 Financial Data Schedule
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